The point is not to live like saints, but to draw connections between our "TGIF nights" on one side and our dependency on corporate employment on the other.
Budgeting is tedious. Yet that do-good voice in our head scolds us when we don’t do it. My biggest beef: budgeting pounds into your head that your income is fixed. For the “busy budgeter,” expenses are the enemy, weeds everywhere, always threatening to wreck the financial scenery. But to claim a lasting victory over the mounting costs of life, you must boost revenues. Managing expenses is part of it, but “budgeting” promotes a feeling of scarcity and uptight self-management.
That said, you do have to understand how money liberates itself from your wallet. You’re not getting out of the cubicle without that know-how. So what’s the alternative? Use the same kinds of financial statements businesses do. We’ve already talked about the balance sheet, which is a snapshot of the overall financial picture. Now we can consider the usefulness of two more tools: the cash flow statement and the income (or profit and loss) statement, which is a component of the cash flow statement.
In the process of compiling the data for these statements, you solve the budgeting problem. The most efficient way to do this is with accounting software. If you download your transactions into that software regularly, you will have all the data you need to crunch some pretty impressive numbers. OK, the numbers themselves may not impress – at least initially – but you can track them over time and (hopefully) they will improve.
The program you choose doesn’t really matter, but I download all my personal transactions into Quicken. I also download my credit card expenses there. When you have all your data in one place, you can do some realistic forecasting. It’s very hard to project forward by looking at last month’s bank statement, because there are too many costs (like car repair) that don’t fall within that timeframe.
But once you extend that horizon to a year or longer, you can make a good calculation of your typical monthly expenses. With a bit of extra energy, you can even classify each expense into a relevant category. But what we’re really after is a scary accurate view of what our total monthly costs are.
Let’s say you have three year’s worth of data in an accounting program. The hard part is getting the data in there – online downloads are the key. Once the data is in, you can generate a report that shows your total expenses over a three-year period. Divide that total by 36, and you have a real working total of what it costs you to live month to month. And since it’s based on three years of numbers, you’ve taken into account all the incidentals, all the pizza deliveries, all the slot machines.
Super old schoolers call this your “nut,” as in: “If I don’t make five grand a month, I won’t be able to make my nut.” Your “nut” is a valuable piece of information, and in the age of credit cards and home equity lines, it’s a hard number to get a handle on – it’s too easy to hide your expenses during a refinance. For some, understanding our “real nut” is a painful piece of information. We want to believe we can live on less than we actually do. Over three years, we can see how vacations and flat tires and wedding presents add up. And we’ll see it much more accurately than we would have using a “wishful thinking” budget that doesn’t account for our weakness for a nice bottle of wine.
There are some obvious things you can do to reduce that “monthly nut.” You can pay off high-interest credit cards (a wise first step), or you can get out from under a car loan. Beyond the debt service, there may be other ways to scrimp and save. If we take the extra step of categorizing our expenses, we will spot embarrassing spending trends. For example, if you classify all the DVDs you buy into their own category, you might be horrified enough to Netflix them instead. Iâ€™m always dismayed by my compulsion to own DVDs that I rarely watch again. Over a three-year period, you can see the absurdity more clearly. That can help firm your all-important resolve.
My expenses have an alarming tendency to rise to my level of income. This is typical, but it’s *not* what we are going for. We are shooting for real profitability each year. We’re looking to generate excess cash we can invest in the creation of assets, or, alternately, put in income-generating accounts.
When you force yourself to go through your downloads each month, it’s not hard to identify the areas you binge on. Binging is part of life, but it’s good to remember the point of the book Your Money or Your Life: we use our money to buy time (life energy), so when we spend money recklessly, we are essentially handcuffing ourselves to our desks, ensuring we will have to slog through our jobs at whatever hourly rate we command. The less money we have, the more costly our indulgences are.
As we accumulate wealth, we can get away with more reckless spending. But when we are trying to break free from the cycle of bad jobs and bad debt, our margin for error is tight, and we pay dearly for our own indulgences. The point is not to live like saints, but to draw connections between our “TGIF nights” on one side and our dependency on corporate employment on the other.
Looking for income and expense trends is similar to how businesses build a cash flow statement. A statement of cash flows totals up the income from all of our revenue sources (work, investments, repaid loans, etc), subtracts all the expenses from that same period (business expenses, personal expenses, debt service, etc) and shows us a gain or loss in cash flows over the period we are looking at. It’s rare to see a cash flow statement geared for individuals, but some software programs will generate them, and if not, you can easily make your own on paper or via a spreadsheet. It’s important to revisit the statement each year to spot overall trends.
A simple cash flow statement, appropriated for personal finance, might look something like this:
JR’S CASH FLOW STATEMENT (for period of August 1, 2005 to August 1, 2006)
Net Income from Operations (Business): $60,000
Net Income from Investments: $250
Net Income from Rental Properties: $10,000
Total Personal Expenses: ($65,000)
Beginning Period Cash: $10,000
Ending Period Cash: $15,250
So, using this simplistic (and optimistic) view of my cash flow, what we see is that my business made a net profit of $60,000, plus I had $10,000 in rental income and $250 in investment income (remember, using our investment rules, I am only counting non-retirement investment income on this statement). So I have three income sources going into my bank account, but then I have outgoing expenses of 65K (the parenthetical indicates this is in fact a negative number for our purposes).
So, what we have here is a net gain in cash flow of $5,250 from the beginning of the year to the end. You can break out the cash flow statement in more detail if you want a closer look at how each line item was calculated. For example, your cash flow statement might indicate total wages and then indicate taxes as one expense subtotal, so that you can see how much tax you pay on your salary each year. A more complex form of the cash flow statement (for a business) can be found on wikipedia.org.
As for the income statement, businesses consider that part of an overall cash flow statement. An income statement is a closer look at an operational piece of business and whether that business made or lost money. An income statement might include investment income or business rental income, but those other sources of income would likely be itemized separately, enabling the finance team to assess the actual revenues and expenses related to the core products and services of that business.
For my cash flow statement, the income statement portion would be a much closer look at how I arrived at $60K in net business income, looking at each expense category and adding them together to compare against revenues. Sometimes income statements are done on an “accrual” basis, which means the statement is based on when business is “booked.” Using an accrual method, money we have invoiced but not yet collected is considered revenue. For our purposes here, we’re sticking with a cash-based income statement.
Income statements are often most useful in a detailed version, but a summary income statement might look like this:
JR’s INCOME STATEMENT FOR HIS ‘S’ CORPORATION, 8/1/05 – 8/1/06
Client A: $125,000
Client B: $4,500
Interest Income: $500
Total Revenues: $130,000
Client A: $37,000
Client B: $3,000
Total Expenses: $40,000
Income Before Taxes: $90,000
Income Taxes ($30,000)
Net Income: $60,000
Note that the net income of $60K now plugs into my cash flow statement above. In my case, income taxes would not actually be included on the expense line of the income statement as my business income is taxed only at the personal level. Another aspect is that while I like to measure my expenses against a particular client – to determine the profitability of that client – most income statements would divide expenses up into categories like “Cost of Goods Sold,” “Selling Expenses,” and “Administrative Expenses.” There’s more than one way to go here; the key is having a summary income statement that you can also “drill” into in order to get specific detail on each type of income or expense (such as being able to compare cellular and land line phone expenses).
So how can we use these statements to improve our financial picture? The income statement is useful for a focused look at a particular venture. For example, I use Quickbooks to track my business expenses and earnings. Within Quickbooks, I have classified my expenses and revenues into different projects, so I can calculate the profit (or loss) of particular venture. I can look at how much profit I have made on my SAP consulting book after deducting the promotional expenses from the revenues.
I can do the same for Resumes from Hell, or any other aspect of my business. I can run a similar income statement for my business as a whole. You might choose to run a side venture at a loss for a period of time, but it’s still very important to be able to see exactly how much you are making (or losing) on each venture you launch. This helps to focus on profitability and figure out which businesses aren’t viable.
If I run the numbers on Resumes from Hell, I can see that I have lost money so far. It is not a profitable venture because our marketing campaigns have been expensive. Every time we market the book, we get excellent coverage and our book sales jump, but not enough to justify the marketing expense. This data factors into future decisions heavily. For example, we could decide to forego traditional marketing and spend more time and resources on Internet-based marketing, which tends to be cheaper than direct mail or cold calling.
There are times in business where you don’t mind losing money or keeping a break-even venture afloat. In the case of Resumes from Hell, we are going to write a companion book called Resumes from Heaven that we think will raise the sales of both titles. But we do need to pay attention to what the numbers tell us. (It is probably worth mentioning that this kind of income and expense detail is also required if/when you consider the option of outside investors or financing. Plus it’s a beautiful thing to have come tax time!).
So an income statement can help you to hone in on how a particular venture is doing. The cash flow statement has a broader purpose. Your accounting software gathers all the material you need for a cash flow statement. In Quicken, I can see all of my expenses, either by cash or credit card. I can also see all my revenues. I can see how much I made (or lost) from my business, which shows up in the form of paychecks or cash distributions in my deposit column. I can also see how much I made from investment income (not much). All the sources can be tracked.
The cash flow statement shows us some important things. We may be struck by how our income from investments (or a side business) has increased. For example, we might find that a year ago, income from our side venture comprised 10 percent of our total income, and our work salary was the other 90 percent. This year, it might be 20 percent from the side venture and 80 percent from our 9-to-5. That’s a positive trend we can take from the cash flow numbers.
It’s important to note that we need the balance sheet to tell the whole story. For example, we might have racked up debt on a credit card but not made payments on that card. We might miss that on our cash flow statement, but the balance sheet would show us whether our consumer debt increased or decreased from year to year. The balance sheet can give us some great summary numbers, but we need all three reports to assess profitability and cash on hand, digging into as much detail as we might want.
Taken together, these financial statements give us an objective view – often irritating at first – of where we stand. But the sting goes away when we realize how much these statements can help us leave the cubicle behind. The best part is yet to come: we can use the cash flow statement to calculate how soon we can retire or make a shift to part-time work. I’ll cover that in my next chapter.
Want to buy Free From Corporate America or see reviews of the final published version from readers like yourself? The printed book is now available on Amazon.com with product reviews.
You can also get a discounted version of the final book in eBook (PDF) format, or you can pick up a copy on the Kindle. The published version of the book is significantly enhanced from the web version available on this site.